A-ROliva-Kallenberg-Managing the Transition From Products to Services

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Managing the transition fromproducts to services

Rogelio OlivaHarvard Business School, Boston, Massachusetts, USA, and

Robert KallenbergPorsche AG, Stuttgart, Germany

Keywords Service, Management, Strategy, After-sales service

AbstractManagement literature is almost unanimous in suggesting to manufacturers that thshould integrate services into their core product offering. The literature, however, is surprisingsparse in describing to what extent services should be integrated, how this integration should carried out, or in detailing the challenges inherent in the transition to services. Reports on a stuof 11 capital equipment manufacturers developing service offerings for their products. Focuses o

identifying the dimensions considered when creating a service organization in the context ofmanufacturing rm, and successful strategies to navigate the transition. Analysis of qualitatidata suggests that the transition involves a deliberate developmental process to build capabilities

rms shift the nature of the relationship with the product end-users and the focus of the servioffering. The report concludes identifying implications of our ndings for further research an

practitioners.

Introduction

Management literature is almost unanimous in suggesting to produ

manufacturers to integrate services into their core product offerings (e.

Bowen et al., 1991; Gadiesh and Gilbert, 1998; Quinn et al., 1990; Wise an

Baumgartner, 1999). The rationale for such integration is normally put fortalong three lines. First, there are economic arguments. Substantial revenue ca

be generated from an installed base of products with a long life cycle (Knechet al., 1993; Potts, 1988); services, in general, have higher margins than produc

(Anderson et al., 1997; The Economist, 2000; VDMA, 1998); and service

provide a more stable source of revenue as they are resistant to the economcycles that drive investment and equipment purchases (Quinn, 1992). Secon

customers are demanding more services. Pressure to downsize to create mor

exible rms, narrower denitions of core competencies and increasin

technological complexity that leads to a higher specialization are some of thdriving forces behind the rise of service outsourcing (Lojo, 1997). Finally, ther

is the competitive argument. Services, by being less visible and more labo

dependent, are much more difcult to imitate, thus becoming a sustainabsource of competitive advantage (Heskett et al., 1997).

The Emerald Research Register for this journal is available at The current issue and full text archive of this journal is available a

http://www.emeraldinsight.com/researchregister http://www.emeraldinsight.com/0956-4233.htm

This research was supported by the Division of Research at Harvard Business School. Thauthors are grateful to Erich Senn and James Quinn for feedback on earlier versions of this pape

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International Journal of ServiceIndustry ManagementVol. 14 No. 2, 2003

pp. 160-172

q MCB UP Limited0956-4233DOI 10.1108/09564230310474138
http://www.emeraldinsight.com/0956-4233.htmhttp://www.emeraldinsight.com/researchregister


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Despite the prot potential that services represent, the list of manufacturingorganizations with strong service strategies is not as long as the literaturewould predict. With very few exceptions (e.g. General Electric, ABB, Otis,Caterpillar, etc.), the manufacturers transition into services has been relatively

slow and cautious (VDMA, 1998). Why is this so? There are three successivehurdles to overcome in making such a transition. First, rms might not believein the economic potential of the service component for their product. As one ofthe interviewees from our study suggested, It is difcult for an engineer whohas designed a multi-million dollar piece of equipment to get excited about acontract worth $10,000 for cleaning it. Second, although a rm might realizethe service market potential, it may decide that providing services is beyondthe scope of their competencies. For example, Digital Equipment Corp. refusedfor years to provide services as they saw computer design as their corecompetency. Finally, a rm might realize the service market potential, decide toenter that market, but fail in deploying a successful service strategy (e.g. Ford

Motor Co.s attempt to enter post-sales services was blocked by its network ofindependent dealerships).

Transitioning from product manufacturer into service provider constitutes amajor managerial challenge. Services require organizational principles,structures and processes new to the product manufacturer. Not only are newcapabilities, metrics and incentives needed, but also the emphasis of thebusiness model changes from transaction- to relationship-based. Developingthis new set of capabilities will necessarily divert nancial and managerialresources from manufacturing and new product development, the traditionalsources of competitive advantage for the organization.

Given the above considerations, the literature is surprisingly sparse indescribing how this integration could be carried out, or in detailing thechallenges inherent in the transition. Even at the strategic level, it is not clearwhat the extent of the service offer should be, or what factors to consider whendeciding on a product-service mix. This silence in the literature prompted ourresearch. This article reports the ndings from a qualitative eld study of 11capital equipment manufacturers known to have initiated an explicit servicestrategy to support their products.

Field study methodology

When articulating our research, we structured our thinking along a continuumfrom pure-product to pure-service providers (Chase, 1981), and thought ofmanufacturing rms moving along that axis as they incorporated moreproduct-related services. At the extreme, we envisioned a service organizationfor which their products are only a small part of their value proposition (e.g.IBM Global Services). Given the lack of complementarity betweenmanufacturing and service capabilities, and previous research suggestingthat manufacturing biases would lead to erosion of service quality (Oliva, 2001;

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Oliva and Sterman, 2001), we expected the transition along this continuum tbe disrupted, and eventually lead to the creation of a new organization with unique service orientation. Accordingly, we designed our eldwork to explorthe evolution along this line (see Figure 1).

We focused on the machine manufacturing industry because it represents mature industry with relatively slow market growth and technologicinnovation. As a result, the industry has been looking to enhance iprotability through services (VDMA, 1998). Industries with products in earliestages of the life cycle (computers, semiconductors) still rely on product anprocess innovations to sustain growth and increase protability. On the othehand, industries well known for their service offerings (elevators, medicequipment, aircraft engines) were thought to have a unique advantage services are normally provided in the context of strict regulations and to btoo far along the implementation process.

To explore rms transitions, we employed an inter-disciplinary researcapproach that included interviews, and a detailed archival assessment of thorganizations experience in integrating services into their product offerin(Eisenhardt, 1989; Yin, 1984). We then developed our process theory anframeworks from these observations (Mohr, 1982; Strauss and Corbin, 1990Consistent with grounded theory development and our goal to develop theoretical model of the transformation patterns followed by rms that haattempted the transition, our sampling was discriminate. Firms were selecteaccording to their perceived position along the product-service continuum, anwere contacted through the Research Institute for Operations Managemen(FIR) at Aachen University. We sampled until we reached theoretical saturatio

for the transformation process, i.e. until a recurring pattern for thtransformation emerged from our interviews (Strauss and Corbin, 1990).

Figure 1.The product servicecontinuum researchdesign

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Our sample included 11 German capital equipment manufacturers withaverage revenues (2000) of DM3,650 million, and average employment of10,450. In each organization, we spoke with the head of the service division and,in most cases, with the chief executive ofcer (CEO) or managing director of the

organization; all interviews were done in August 2000. Each interview wasconducted according to a semi-structured interview protocol based on theframework presented in Figure 1, and lasted between 60 and 90 minutes.However, given the nature of the research, the interviewees were not requiredto stay within the standard questions. Several participants were contactedsubsequently to elaborate on issues raised or to clarify comments. Wesupplemented the interviews with information publicly available about therms performance, operations and service offering.

Servicing the installed base

In describing the service elements provided by manufacturing rms, severallabels are used in the literature: industrial services, service strategy inmanufacturing, product-related services, product-services, or after-salesservices. A common theme in this literature is the motivation of showinghow services can complement the sale or lease of a tangible good, and theirimportance for the growth and competitive success of a manufacturingcompany (Mathe and Shapiro, 1993, p. 33). This motivation, which is rooted inthe past neglect of services in manufacturing rms, can be characterized asbetter services to sell more products. Although we acknowledge theimportance of the product/service interface in the sales function, our eldworkyielded a different focus on services provided by manufacturing rms, which

also resonates in the most recent literature (Patton and Bleuel, 2000; Wise andBaumgartner, 1999): managing the services relating to a products installedbase.

Durable manufactured products (capital equipment and consumer durablegoods) when originally purchased are put to use for their useful life. Suchproducts require services as they advance through their life cycle (acquisition,installation, operation, upgrades, decommission, etc.), and have associated acost of ownership beyond the purchase price (spare parts, consumables,maintenance, etc.). A products installed base (IB) is the total number ofproducts currently under use; IB services is the range of product- or process-

related services required by an end-user over the useful life of a product inorder to run it effectively in the context of its operating process. While notdenying that manufacturers of consumable goods may benet from explicitservice strategies, we believe that IB services are large enough to warrantspecial consideration durable products represented 60 per cent of the USindustrial production in 2001 (Federal Reserve, 2002). Focusing on the uniqueattributes of IB services enables a new framing of the service marketopportunity, what is required to compete in it, and the challenges for


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manufacturers to enter that market. We briey discuss each of these pointbelow.

First, when dening services in relation to a products IB, some of thdenitions found in the literature on product-related services may be relaxe

.

Services are not restricted to services bundled with the product: Iservices encompass all services required by the end-user to obtain desired functionality, i.e. use the product in the context of its operatinprocess.

. Service suppliers are not restricted to product manufacturercomponents manufacturers, system integrators, end-users maintenancunits and third parties (other manufacturers or independent servicproviders) also compete in the IB market.

. End-users are not restricted to be industrial rms: this distinction iimportant when focusing on the role of services for customer relations

The IB framing leads to a more competitive market with greater size and scopNevertheless, by integrating the value chain from product design to servicprovider, product manufacturers have unique advantages when serving theIB:

. Lower customer acquisition costs: since manufacturers are involved in thsales of new products, they have information on new equipment joininthe IB.

. Lower knowledge acquisition cost: many of the services provided to an Irequire special knowledge about the product and its technology. Thproduct manufacturer has an additional advantage as it has knowledge

the product service requirements over its life cycle.. Lower capital requirements: manufacturers possess many of th

specialized production technologies required to fabricate spare parts oto upgrade existing equipment.

Finally, in terms of challenges, the manufacturer attempting to enter the Iservice market faces the difculty of managing two tightly-coupled marketOn one hand, increasing service quality and scope might extend the productuseful life, thus reducing its replacement sales. On the other hand, increasinthe quality and durability of products might reduce future service revenueThese challenges add to the normal difculties of creating a service network tsupport a geographically distributed IB (see below).

From product manufacturer to service providerThis section summarizes our ndings on how organizations in our samplincorporated services into their offering. Our analysis of the actions taken bthe rms found a recurring pattern on the adoption of IB services. Thobserved commonalities were not in the specic service provided, but in th

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nature of the service contracts and in their adoption sequence. Furthermore, ouranalysis suggests that the transition occurs in stages, and from these wedeveloped a process theory for the transition (see Figure 2). During each stage,the rm focuses on a set of issues and addresses them through the development

of new capabilities. Space considerations do not permit us to illustrate eachstage; instead, we will focus on the conditions triggering the move, the rationalefor the implemented changes and their sequence.

Consolidating the product-related service offeringMost manufacturing rms provide services to sell and support their product; ina way, they already are in the market of product-related services. Thoseservices, however, have traditionally grown in different parts of theorganization, are fragmented and considered an unprotable necessity to sellthe product. The rst step taken by the rms in our sample that were

successful in developing a service offering, was to consolidate the rms

FigureProcess model

developing IB servcapabilit


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existing service offering under a single organizational unit. The consolidatioprocess is normally driven by a desire to sell more products and its goal is timprove the service performance. It is typical for organizations to nd thaservices are an important component of the consumer satisfaction indicator

and to consider this integration the rst step to improve the delivery of thosservices.The consolidation of the service offering is normally accompanied by

strong initiative to improve the efciency, quality and delivery time of thservices provided, and the creation of additional services to supplement thservice offering. The consolidation of services also comes with the developmenof a monitoring system to assess the effectiveness and efciency of the servicdelivery. This monitoring system allows managers, for the rst time, to realizthe size of the service market and account for services contribution to thrms operations.

Internally, these changes create the transparency of numbers needed to g

a clear sense of direction and to monitor the success or failure of executechanges. Externally, the improvement of quality of existing serviceestablishes a reputation among clients as a reliable service provider.

Entering the IB service marketEntering the IB services market implies identifying a prot opportunity withthe service arena and setting up the structures and processes to exploit it. Threalization of the prot potential often comes via the monitoring mechanismimplemented in the previous stage, or after seeing a competitor work with higmargins in the service market. Although the triggers for organizations t

decide to go into this market differ (change in top management, successfucompetitor or customer satisfaction survey), the process followed borganizations in this stage is predictable.

There are two major challenges in performing this transition into the Iservices. The rst difculty reported in performing this transition is threquired cultural change for a product-centered organization to become servicoriented. It is difcult for an organization built to design and deliver compleequipment to get excited about the possibility of repairing it. The economicof the service business are different from the economics of the product markemaking it difcult for the sales organization to focus on small service offering

Furthermore, in manufacturing rms, services are often thought of as add-onand initial services (installation, commissioning, etc.) are frequently giveaway during the negotiations to sell the product. At the core of this culturatransformation, then, the manufacturing rm must learn to value services anhow to sell, deliver and bill them.

We found that a critical success factor for this transition is the creation of separate organization to handle the service offering. In our sample, these newcreated units had a dedicated sales force (different from the new equipmen

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sales force), their own service technicians, and an information system tomonitor the business operations and to achieve accounting transparency for thenew business. It is with this information system that the case is often made tothe rest of the organization on how important services are for the overall

protability of the rm. In our sample, the most successful rms in extractingvalue from the IB services were those that ran this service organization as aprot center (or a separate business unit) with prot-and-loss responsibility.Our interpretation is that the new organization effectively protects theemerging service culture with its metrics, control systems and incentives from the values and incentives predominant in the manufacturing organization.

The second major difculty reported at this stage is the need to create aglobal service infrastructure that is capable of responding locally to therequirements of the IB. This presents multiple difculties. First, there is theinvestment decision to build an infrastructure that, in all likelihood, will notgenerate revenues immediately, and is likely to dilute some of the operating

ratios that investors monitor. Second, at the operational level, two newcapabilities have to be developed to run a distributed service networkeffectively: the capability to diffuse knowledge across the network (certicationof service centers, etc.) and the ability to manage large organizations of servicepersonnel. Third, the network has to make an explicit decision about the degreeof standardization of the service offer in order to balance between thetransferability of services across markets vs customization for individualend-users.

Early in this stage, the rm traditionally takes services that it currentlyoffers and puts them under prot-and-loss accountability. Once the case for the

service unit has been made, service organizations tend to start expanding theirIB service market either by expanding the service offering to other product-centered services, or by acquiring additional IB, that is, becoming the serviceprovider for third party equipment.

Internally, the focus in this phase is to build a well-functioning serviceorganization, and to develop the metrics needed by a service organization tomeasure customer satisfaction, employee satisfaction, and business success.Firms use this stage to ne-tune the organization further and to expand thebusiness, thereby creating credibility inside the organization. Externally, theorganization is establishing itself in the market as an active player with areputation for actively seeking out opportunities and delivering on promises

made. Most companies rst establish themselves rmly in the basic IB servicebusiness before moving to the next stage.

Expanding the IB service offeringThe expansion of the service offering takes place once the core functionality ofthe service organization has been set, and it occurs through two distincttransformations. The rst transition is to change the focus of customer


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interactions from transaction- to relationship-based. Moving along thdimension (vertical axis of Table I) changes the way the service is priced: froma markup for labor and parts every time a service is provided, to a xed priccovering all services over an agreed period. The effect of this form o

contracting is that the service provider assumes the risk of equipment failurRelationship-based services centered around the product normally take thform of maintenance contracts priced in terms of operational availability anresponse time in case of failure. The move towards maintenance contracts ioften triggered by a desire to make better use of the installed servicorganization. For the service provider, once the service organization is in placit becomes a xed cost and the main driver of protability is capacitutilization. Established service contracts reduce the variability anunpredictability of the demand over the installed capacity, and allow higher average capacity utilization.

While the capacity utilization argument explains why a service provideshould look into offering service contracts, there is no compelling argument owhy end-users should outsource the maintenance function. In order to make thoffer tangible to the end-user, the pricing of these services has to be done othe basis of equipment availability, and not based on the providers cost omonitoring the equipment, and performing scheduled maintenance anemergency repairs. Although an impressive technological feat, manorganizations have struggled to sell their condition monitoring capabilitie(remote monitoring) for their products. The problem is that the conditiomonitoring capability per se does not add value to the end-user. It is only whe

Product-oriented servicesEnd-users process-orientedservices

Transaction-based services Basic installed base services Professional servicesDocumentationTransport to clientInstallation/commissioningProduct-oriented trainingHot line/help deskInspection/diagnosisRepairs/spare parts

Product updates/upgradesRefurbishingRecycling/machine brokering

Process-oriented engineering(tests, optimization, simulationProcess-oriented R&DSpare parts managementProcess-oriented trainingBusiness-oriented trainingProcess-oriented consulting

Business-oriented consulting

Relationship-based services Maintenance services Operational servicesPreventive maintenance Managing maintenance functioCondition monitoring Managing operationsSpare parts managementFull maintenance contracts

Table I.The IB service space

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that capability is transferred into an offer of higher equipment availability, andpriced accordingly, that the end-user has the ability to quantify the value of theoffering.

Pricing equipment availability requires the service provider to assume the

equipments operating risk, i.e. pricing will be based either on the opportunitycost of machine failure, or the traditional maintenance cost for the end-usersmaintenance organization. Protability under this pricing mechanism dependson how accurate the organization is in assessing the failure risks for theequipment. This requires a new set of skills within the service organization andinformation gathering capabilities to determine risk better. Although mostorganizations do not have the historical data to predict failure rates, we saworganizations willing to develop the risk assessment skills through experience

i.e. they were willing to take unprotable maintenance contracts to startdeveloping those skills. In terms of providing a cost advantage, it is normallypossible for the service provider to pass on the benets of higher utilization of

the established service capacity as a lower price for the maintenance of theequipment. However, the main advantage that manufacturers have over othermaintenance organizations is their cumulative experience in maintaining theirown equipment, and the use of their product development and systemsintegration expertise to develop and deliver better maintenance practices.Externally, this step requires marketing efforts and time, as the rm needs toestablish an ongoing relationship with the end-user.

The second transition changes the focus of the value proposition to theend-user from product efcacy whether the product works to the productsefciency and effectiveness within the end-users process. As the service

provider moves along this dimension (horizontal axis of Table I), the productbecomes part of the offering as opposed to being the center of the valueproposition. Although many manufacturers provide technical or professionalservices as part of a pre-sale effort, centering the offering on the end-usersprocess is equivalent to shifting the emphasis of the business from machinemanufacturer to solution provider and developing services to support andimprove continuously the utilization and effectiveness of the installed base.The big step required in this stage is to provide these services for an installedbase over its complete life cycle as opposed to services required for theinstallation and commissioning of new product.

Establishing process-centered services presents two important challenges.First, the rm needs to replicate, for a professional service infrastructure, theHR and knowledge management capabilities developed for the service network.The second challenge is a marketing challenge. The service organization needsto develop new networks to work with a new distribution channel and adifferent set of contacts within the end-user organization. The structuresneeded to succeed in this space may resemble those of professional servicerms.


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The service offerings beyond transaction-based and product-orienteservices require the development of signicant capabilities. The two directionsuggested above towards relationship contracts or towards process orienteservices seem to represent orthogonal developments with few infrastructur

and capabilities synergies. Although maintenance services seem to leveragbetter the infrastructure developed for the basic services, our eldworprovided no evidence to suggest advantages of entering one of these spacebefore the other. However, given the signicant challenges that a simultaneouentry into both elds represents, it may be advisable to tackle thesequentially.

Taking over the end-users operationsAdvancing in the two dimensions yields the pure service organization onthat assumes operating risk and takes entire responsibility of the end-userprocess (see Table I for examples). The move into the eld of operationa

services, which includes taking over an end-users maintenance or operatinorganization, is a largely uncharted territory for manufacturers in moindustries, and no organization in our sample had yet moved into this spacFrom a capability perspective, a rm should take this step only after itservice organization has established itself rmly in the maintenance anprofessional services market. Given their current state as early stage servicproviders, this is a transition that most manufacturing rms probably winot initiate soon.

Implications for research and practice

In terms of future research, we believe that there are unaddressed issueassociated with the hurdles identied for manufacturers to move into service

namely: the evaluation of the IB service potential, and the extent to which rm should enter the service market. Decision support models to quantify thIB potential, and to aid in deciding if and when in the product life cycle rm should enter the IB market, seem like a promising research avenue. Just aproduct and market attributes determine the protability potential from the IBwe believe that organizational attributes dictate the extent to which a rmshould move along the product-service continuum.

At the implementation level, the third hurdle, most challenges seem to be i

the organizational change domain goals, incentives, change managemenetc. The framework developed here, by identifying the developmentcapability requirements of each stage and viable organizational solutions fointegrated service providers, provides the rst step in determining the goals fothe transition. In this context, our ndings have direct managerial implication

First, while the stages described above do not always happen idistinct sequence, in all successful organizations there was a deliberatsystematic and well-structured transformation effort. Our data sugge

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that there is a particular order in which rms need to tackle challengesand develop capabilities; rms attempting to sell advanced services e.g.maintenance or professional without having developed the capabilitiesand prociency in basic product-oriented services was a failure mode that

we observed several times. The framework presented above suggests adevelopmental approach-based on capabilities to the challenge ofbecoming a service provider. By identifying the required skill set for thenext stage, the framework allows management to concentrate on a plan todevelop or acquire it.

Second, while it is possible for a rm to provide product-related serviceswithin the context of a manufacturing operation, we found that rms that werefully exploiting the market opportunity for IB services had isolated theirservice operations and personnel from the manufacturing and productplacement operations. Although we had expected this separation of activities inthe most advanced service providers, we expected organizations in the early

stages of developing service offerings to be leveraging the manufacturersadvantages in IB services (see the section entitled Servicing the installedbase), and were surprised by how early in the transition process rms createda separate service organization. It is not clear from our data, however, if thesuccess of the isolated service organizations was due to the additionalmanagerial focus these organizations received, or if, as we expected, culturaland managerial biases are responsible for thwarting the service developmentefforts in product-centric cultures.

Finally, the early separation of service and manufacturing operations raisesthe question of how organizations can leverage the advantages of the

manufacturing rm when moving towards operational services.Manufacturers advantages seem to diminish fast beyond basic services,suggesting intermediate stopping points in the transition spectrum, or muchhigher investment to provide advanced services. We saw little evidence ofvertically integrated models to provide services in our sample. Instead,manufacturing rms may have to adopt horizontal service delivery structureswhen moving into operational services. In these structures, a service integratorwould be orchestrating the delivery of operational services by a network ofservice players including manufacturers, maintenance and logistics specialistsand professional service rms.

Our sample was small, bounded to one industry, and, perhaps due to theindustry focus, limited to rms in the early stages of the transition intoservices. Further research is necessary to assess the experience and challengesof companies further into the transition process. Development of these ideascould prove especially useful to rms facing the challenges of productcommoditization e.g. computers, electronics, autos and that are lookinginto services as a way to differentiate their offering, satisfy their customers andimprove their nancial performance.


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